Latest posts by Kumiko Ehrmantraut (see all)
- What is the Rule of 72 and Why Does It Matter? - October 14, 2020
Welcome to the first step in creating a budget! This might seem to be a pretty straightforward topic. However, some find this area challenging.
Knowing your income, in most cases, is pretty easy. You get paid on the 5th and 20th of the month, and it’s the same amount every paycheck. But what happens when you start to track income that is inconsistent?
Expenses is another topic that can seem pretty elementary. You pay $60 a month for your utilities and $40 a month on your phone bill – sounds like a cinch right?
Well let me be the first one to say, this is the area I struggled with the most. Pinpointing your spending is a much harder thing to do. Don’t worry – I’m here to help you with this crucial first step! There is one rule I want you to keep in your head as you read this post – ALWAYS budget for the worst case scenario! It’s ok. I will explain this a little later in the article!
INCOME
If you have consistent income, yay for you! This step is easy.
Let’s talk about inconsistent income. The first step in dealing with irregular income is to create a monthly cash flow plan (I know I am getting into things I have not yet discussed – but bear with me).
This will be used to determine how much you “need” each month just to get by. So let’s discuss this little thing we call the cash flow statement – or commonly called the statement of cash flows.
This is merely a document that is used to record the amount of income you reasonably expect to bring in and the expenses that are going out.
These expenses should be listed in order of priority. Once you give weight to each of your expenses, it makes it easier to determine what has to be paid, versus what can be put on hold.
On any given month you might not be able to buy clothing or new shoes, but you'll know that your top priorities can be taken care of. What a significant relief right?
Try to mimic a steady paycheck as much as humanly possible. This is where that little rule I wanted you to remember comes into play – plan for the worst-case scenario.
On a piece of paper list the income you have received over the last two months and circle the lowest paycheck you received over that time frame. This is the amount you can use as a starting point and is the value you will use to cover all of your monthly expenses and top priorities.
If one month you are not able to cover your monthly expenses with this value, you use the priorities you created above to eliminate some of the lower priority expenses.
Another option I am going to suggest when you are dealing with irregular income is to open a separate checking account (please, please, please check the fees at the bank you choose).
This bank account should be labeled as your paycheck account for your irregular paychecks. You will then withdrawal the predetermined amount you figured from the step before (refer to the above bold text).
This withdrawal will be consistent based on the time frame you choose to budget. Are you budgeting for every two weeks or every month? Deposit this amount into your regular personal checking account and pay your expenses. If your paycheck is higher than your predetermined amount, leave it in your paycheck account and let it grow to use for months your paycheck is lower than expected.
Dave Ramsey has some amazing PDF tools to help you get started with creating a cash flow statement!
Expenses
There are two fundamental terms I want to cover when talking about expenses:
Fixed Expenses: These are expenses in your monthly budget that never change. For example, your car payment will always be $250 a month. Your mortgage with always be $800 a month. The values of these expenses are what I like to call “in stone.” There is no option to reduce them, in most cases. Essential expenses are also usually the top priority expenses on your cash flow statement. These type of expenses are paid month-to-month without changing much in amount.
Examples of fixed expenses include:
• Rent/Mortgage
• Car Payment
• Life Insurance Premiums
• Cable/Internet
Variable Expenses: These expenses are the ones I like to discuss. Why? Variable costs are not set “in stone.” For example, one month you might spend $30 on clothes, the next month you might spend $400.
You have complete control over how much you spend on these items. That’s the fun part. If you are tight one month on your budget, you can tell yourself “ok, I don’t have enough money to spend $500 this month on groceries, so I will alter my meal plan and bring it down to $300.” This is a great thing – is it not? These expenses are usually on the bottom of the priority list (minus the food part- we all have to eat).
Example of variable expenses include:
• Clothes
• Food
• Entertainment
• Household Items
Once you are aware of all the things you spend your money on, you should be able to categorize your spending into Fixed and Variable expenses and then prioritize them.
There are a few more pointers I want to touch base on with expenses.
Each month might vary. This can get frustrating for some people (you know who you are). You want to see the same thing happening every month and for things to be consistent. With this attitude, you are more likely to fail, and I can’t have that.
Remember, this is what we call life. It happens, and unexpected things arise. That's why it's so important to budget for emergency savings. It's ok for your budget not to work one month. Pick yourself up and start fresh next month. I believe in you!
Each cent of your income should have a job. Whether that is paying for a bill or taking care of a “want” item, it must have a purpose.
You are more likely not spend money if the money you have is already allocated for another purpose. At the very end, when you add up your income, and you subtract it from all your expenses, it should be $0. If not, grab that calculator, and check again. You might have to make adjustments.
Your expenses do NOT have to have 1000 categories. Make it simple for yourself! Here are the categories I use in my budget:
• Bills
• Food
• Clothing
• Entertainment
• Everything Else (low low priority)
See? Keeping it simple is keeping it real. Don’t get overwhelmed by the details. If you need to make adjustments in your budget, the one place to go are those variable expenses. Remember, you control those values, so they will be easy to alter.
Figuring out where your money is going and how much you have to spend is the first step in creating a working budget.
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